What next for annuity rates? Predictions from a pensions industry expert

Annuities, which are bought by those retiring in exchange for providing an income, have been collapsing for some time due to the Bank of England’s money-printing efforts. The past 12 months has seen a resurgence in annuity rates, providing better payouts for retirees, but the question remains whether this rise will continue in the foreseeable future.

We round-up the latest on annuity rates and take a look at where they're headed with regular commentary from one of the UK's leading annuities experts, Billy Burrows of Annuity Line.

Analysis: Billy Burrows

Latest commentary from Billy Burrows- September 2013

2013 has been a good year so far for annuities with the
benchmark annuity rate (£100,000 annuity for a male age 65, partner aged 60,
joint life 2/3rds, guaranteed 5 years and level payments.) increasing 8 per cent since
the beginning of the year.

The reason for the rate increase is simply that the returns
on longer-term interest rates on which annuities are priced has increased
significantly. The yield on 15-year gilts has increased from around 2.5 per cent in
January 2013 to over 3.25 per cent in August 2013.

On 5th September the
yield was 3.35 per cent, which is the highest this yield has been since two years ago in
August 2011.

Yields have bounced up

The recent bounce in yields started on 12 th August and yields have increased from 3.04% to over 3.35% in the space of 24 days. Consequently all the top annuity providers have increased their rates. The table below shows how the top providers have changed over the last few weeks. Canada has increased rates by about 2%, Aviva by about 1.5% and L&G by about 1.5%.

Rising: This chart shows how 15-year gilt yields have been rising this year.

Looking to the future

It is always difficult to predict annuity rates in the future but for annuity rates to rise another 8 per cent as they have done in the first half of the year, the underlying 15 year gilt yield has to increase from its current level at around 3.25 per cent to over 4.25 per cent. In the current climate this seems unlikely.

A more likely outcome is that annuity rates may nudge upwards slightly over the coming months but it is unlikely that the second half of the year will see the large increase in rates experienced so far this year.

Forward guidance and the interest rate paradox

Mark Carney, the governor of the Bank of England, recently announced the 'forward guidance' policy whereby the Bank will not consider raising interest rates until the unemployment rate falls under 7 per cent.

However if inflation rate increases above 2.5 per cent in the medium term the bank could increase interest rates to combat the inflation threat.

There now seems to be an ‘interest rate paradox’. Why are longer term interest rates, such as long term gilt yields, rising while the bank rate looks to remain low for the next couple of years?

The answer is that the Bank of England can control short-term rates but the financial markets determine longer term gilt and bond yields.

Response: Annuity rates have been increasing in response to the rising gilt yields.

These are rising because US and European economies are improving and the end to the policy of Quantitative Easing seems to be in sight.

QE has had the result of keeping long term gilt yields low and the ending of the ‘printing money policy’ is causing yields to rise.

So what does this mean for annuity rates? If one of the effects of ‘forward guidance’ is to dampen down long-term interest rates then we should not expect significant increases in annuity rates in the near future unless there are some surprises in store for example higher inflation.

There is general consensus that annuities will be higher at some time in the future; it is just that nobody knows when that will be.

The advice for anybody considering purchasing an annuity is take as much time as is needed in order to decide what is the right option but once a decision has been made it might make sense to act straight away, as those who defer their annuity purchase in the hope of getting a higher income are often disappointed.

An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in an approved, tax-free pension scheme.

Most people will buy one with their pension pot in retirement. It is the conventional way of converting this into income. There are others, such as 'drawdown', but advisers usually recommend that only those with larger incomes go down this route. If you've got a chunky pension pot to play with, speak to an adviser to find the right option for you. Find a qualified pensions adviser near you.

There are different types of annuity. The vast majority of annuities are conventional and pay a risk-free income that is a guaranteed for life. The amount you receive will depend on your age, whether you are male or female (this will change in December 2012 following an EU ruling) the size of your pension fund and, in some circumstances, the state of your health.

You may want to think of an annuity being like an insurance product in reverse. You loan an insurance company your capital and they contract to pay you regular monthly installments for the rest of your life.

The amount you get each year is dependent on the annuity rate available when you retire. Unlucky retirees buy an annuity only to see the price they'd have received rise the next week. Lucky ones will retire at the top of the market.

HOW ANNUITIES HAVE PERFORMED

Year ending

Annuity

Gilt Yield

FTSE performance

Source: Burrows and Cummins December 2009

Dec-91

-12.00%

-18.00%

22.00%

Dec-92

-6.87%

-12.99%

11.46%

Dec-93

-12.45%

-21.59%

11.25%

Dec-94

11.33%

34.33%

-9.86%

Dec-95

-6.10%

-9.36%

15.12%

Dec-96

-0.82%

-1.16%

9.55%

Dec-97

-5.78%

-19.28%

18.01%

Dec-98

-10.18%

-24.58%

8.37%

Dec-99

1.24%

8.86%

26.88%

Dec-00

-1.21%

-9.96%

-4.10%

Dec-01

-10.72%

5.51%

-15.38%

Dec-02

-12.45%

-7.48%

-24.07%

Dec-03

1.98%

15.37%

21.73%

Dec-04

-2.94%

-2.72%

4.28%

Dec-05

-1.00%

-8.53%

12.65%

Dec-06

1.89%

9.25%

7.65%

Dec-07

3.24%

-2.12%

3.05%

Dec-08

-0.95%

-3.58%

-33.10%

Dec-09

-8.17%

4.01%

17.05%

Once you buy an annuity the rate is fixed so even if rates go up in the future your annuity payments stay the same. That's why this 'what next' round-up could be so important to your decision - you'll know where you stand.

Annuity rates are priced according to the yield on long dated gilts (Government bonds) and other fixed interest investments, not the bank rate.

This can be confusing because the interest rates on long dated gilts are normally higher than short term rates and at the moment the bank rate is 0.5 per cent whilst the yield on 15 year gilts is about 2.1 per cent.

How your postcode affects your retirement income

Another factor is the postcoding effect. Most of the top providers are now pricing annuities based on where people live. The theory is simple; those living in Glasgow and living on a diet of fried mars bars and chips will probably not live as long as those living in Surbiton and buying their food from the local health shop.